US public colleges expand PE investments despite downturn

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US public university endowments are increasing investments in private equity even as the underperforming asset class has weighed on their private college peers in recent years. 

Seven public university endowments told the Financial Times they were increasing allocation to PE by as much as 150 per cent over the next few years in a bid to boost long-term returns.

The push into illiquid assets comes as a prolonged high interest rate environment and a slump in IPO and dealmaking has depressed PE valuation. In that environment, public endowments see falling valuations as a prime opportunity to enter the space, as expectations for public market returns dim.

Analysts said the PE boom among public university endowments, known for their cautious investment approach, signalled a shift in the landscape, with new players gaining ground and established ones holding back. 

“Public equity returns will become more muted in the years to come,” said John Alexander, chief investment officer of Clemson University Foundation, which plans to increase its PE allocation to 24 per cent from 18 per cent within the next four years. “Private equity will maintain their risk premium over public equity markets.”

While Ivy League endowments were early and aggressive investors in PE, their public counterparts have been slower to enter the field. The top 10 private university endowments allocated last year an average of 36 per cent of their assets to PE, compared with 25 per cent among 40 major public endowments, according to Old Well Labs, a financial data provider. 

But “if Yale and Harvard are not re-upping their top-quartile managers because they are pulling back, those managers are going to get the dollars from somewhere else”, said the chief investment officer of a Midwestern public university endowment.  

A low-risk appetite has contributed to public endowments’ slower pace. David Anderson, chief executive of the $1.8bn University of Utah Growth Capital Partners Foundation, said the university’s endowment — which as of April is overseen by the foundation — had previously maintained a 10 per cent target allocation to PE because of its “conservative decision makers”.

“Often, institutions have very conservative decision makers,” Anderson said. “They just say no risk.”

Public endowments have also lacked access to top-tier PE funds due to their smaller size and location outside financial hubs. Alexander said his endowment started investing in venture capital more than two decades after leading private endowments, known for their deep pockets and proximity to financial centres, entered the space.

“Their venture capital isn’t venture capital I have access to,” Alexander said. “It is tough to get good access for smaller institutions.”

The ongoing PE downturn — marked by a drop in investment exits and distributions — has shifted the landscape as Ivy League endowments trimmed new commitments while their smaller public peers expanded their footprint in the space. 

Anderson said the Utah university organisation raised its target PE allocation to 30 per cent from 10 per cent late last year to improve long-term returns — even though its small exposure to the asset class had made overall performance look “pretty good” in the short run.   

He blamed the foundation’s 5.9 per cent 10-year annualised return, an “unsustainable level for the institution”, on a lack of PE exposure.

“The PE market is far less efficient than the public market,” he added. But “there are more opportunities to be able to get excess returns”.

While PE has underperformed for several years, most public endowments expect the asset class to regain strength in the years ahead.

“As long as we are compounding above our cost of capital and our assets are fairly valued, we have a reasonable tolerance for long hold periods,” said Michael Stohler, chief investment officer of University of Wisconsin-Madison’s $4.3bn endowment.

Analysts warn PE may face further stress before things get better.  

Hunter Lewis, founder of Cambridge Associates and a co-inventor of a private asset-focused investment model, said it would “probably be a mistake” for public endowments to increase exposure to PE, as overvaluation and persistently high interest rates continued to weigh on the asset class.

“I don’t think we are anywhere close to the bottom of private equity,” said Lewis.

Some public endowments are keeping their allocations where they are. Bruce MacDonald, chief investment officer of Virginia Commonwealth University’s $2.3bn endowment, said his endowment would maintain its 18 per cent PE allocation in the coming years.

“We are not seeing this as a great opportunity to add to privates,” he said.